January 2, 2019
By: Jennifer L. Barton
Here are some of the changes made to the Internal Revenue Code by the recent Tax Cuts and Jobs Act of 2017.
Generally, the new law reduced the corporate tax rate, modified the tax brackets, increased the standard deduction and family tax credits, while reducing itemized deductions and eliminating personal exemptions.
Standard Deduction vs. Itemized Deductions
As under prior laws, tax filers will opt to take the standard deduction or itemize their deductions on their tax returns. The standard deduction for 2018 under the new law increased for single filers to $12,000 and for married filers to $24,000. Given the higher standard deductions, many taxpayers will choose to take the standard deduction rather than itemize their deductions. The deductions for those taxpayers who choose to itemize have also been modified – a few of these modifications are discussed below. The increased standard deduction coupled with the changes made to the itemized deductions reduces some of the tax incentives of home ownership.
In the event home owning taxpayers opt to itemize their deductions, they will now only be able to deduct interest payments on total mortgage debt of up to $750,000. Formerly this was $1,000,000. The good news for people who previously incurred debt up to $1,000,000 prior to the new rules going into place, they are grandfathered in under the Act.
Interest deductions for other home equity debt, including home equity loans and other second mortgages, were changed. If the HELOC or second mortgage is used to buy, build or substantially improve the taxpayer’s home that secures the loan, then the taxpayer may still deduct the interest. A taxpayer no longer has the ability to use a second mortgage to pay personal living expenses, etc. and still deduct the interest.
These interest deduction rules apply to second homes as well. Taxpayers are subject to an overall cap of $750,000 in mortgage debt – this includes first mortgages on primary residences, HELOCs and other types of second mortgages, and mortgages on second homes.
For example, in January 2018 a taxpayer takes out a $300,000 mortgage to purchase a personal residence. The loan is secured by the residence. In March 2018, the taxpayer takes out a $200,000 HELOC, which is also secured by the residence, and uses $100,000 to improve the personal residence and $100,000 for personal expenses. Then in May 2018, the taxpayer takes out a $250,000 loan to purchase a second vacation home. The loan is secured by the vacation home. The total amount of debt does not exceed $750,000, but $100,000 of the HELOC was used for personal expenses. The taxpayer should be able to deduct interest on $650,000 of the $750,000 in debt.
State and Local Tax Deduction
While state and local taxes can still be deducted, the amount allowed is no longer unlimited. The new law allows a combined deduction amount of $10,000 only. This includes state income taxes and local property taxes. This particularly harms higher earners who live in higher tax states like Illinois.
While taxpayers can still benefit from the above deductions if they itemize, given the increased standard deduction amount, many taxpayers will likely take the standard deductions.
Capital Gain Exclusion
Homeowners are still eligible for a tax exclusion up to $250,000 of gains if filing single and up to $500,000 if married and filing jointly, provided they live and own their home for two out of the last five years.